Debt consolidation: Personal loan vs. credit cards

6 min read

Paying off debt is one of the keys to financial freedom. Debt consolidaiton is a handy financial strategy that can help consumers achieve that freedom. There are a few options available, which include using a personal loan or a credit card to pay off debt.

With a personal loan, you borrow a specific amount from the bank then repay it back in monthly increments. Meanwhile, with a credit card, you can do a balance transfer. This is where your credit card company pays off the debt with your original lender, then you pay your credit card provider until the balance is zero.

There are advantages and drawbacks to using both approaches. Understanding the pros and cons of personal loans versus credit cards to help you determine which option is right for you.

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How personal loans work

Depending on the provider, there are several ways to use personal loans to pay off debt. The first is to use a debt consolidation loan. How it works is upon approval, the lender sends a check to your creditors to pay off the original balances. Next, you make payments to that lender until the debt is satisfied.

There’s also the do-it-yourself option. With this, you receive approval from your lender then pay the debt(s) off directly. In either instance, the lender outlines repayment terms in their Truth in Lending Disclosure. And you’ll make fixed monthly payments until you pay off the debt.

Pros of perosnal loans

With a personal loan, you know upfront the total loan costs. This includes the amount borrowed, the cost of interest, and any fees associated with the loan. Moreover, you’ll also pay a fixed amount monthly, making it easier to budget this expense.

Another benefit is personal loans could be the less expensive option. Credit cards offer low introductory rates, where if you transfer the balance to them you won’t pay interest for the first year. However, if you don’t pay off the debt in the first year the interest rate could be higher than a personal loan, resulting in you paying more in total loan costs.

Cons of perosnal loans

In some instances, personal loans can be a more expensive option. Some lenders charge higher interest rates and origination fees which range from 1% to 6% of the total loan. If you’re borrowing thousands of dollars, this could equate to hundreds of dollars in fees just for using the loan.

As noted above, credit cards offer a low introductory period where you won’t pay interest. If you have the means to pay the debt off in the next year, then this is an interest-free way to do so. Personal loans don’t offer you this benefit.

How balance transfer credit cards work

To start, you apply with the credit card company. During the application, they’ll ask if you want to transfer balances. For this, you’ll need information about the debt owed such as lender name, address, the balance owed and account number.

Upon approval, they’ll send a check to each of your lenders and apply that debt onto your credit card. To demonstrate, if you’re approved for a $10,000 credit line and transfer $5,000 of debt onto your credit card, your remaining available credit is $5,000. From there, you make payments until you zero out your balance. And you’ll have an available credit of $5,000 you can use for other purchases.

Pros of balance transfer credit cards

You gain flexibility when using balance transfer credit cards to pay off debt. The reason for this concerns the introductory rate. Many providers offer you up to a year or more of interest-free balance transfers, giving you the ability to pay off this debt with minimal additional costs.

Furthermore, a credit card is an open line of credit, meaning you have access to the available balance as long as the account is active. This can help you should you decide to consolidate more debt.

Cons of balance transfer credit cards

Unlike personal loans where your balance is capped, with a credit card, you have a revolving line of credit. Using the example above, if you have $5,000 in available credit, that’s more money you can add to your existing debt.

This could add years to paying down debt. If you pay the minimum balance each month and continue to use your credit cards, the interest will eat into your monthly payment significantly.

In addition, providers charge balance transfer fees which is a percentage of the total balance owed. Depending on how much you owe, this could translate to hundreds of dollars in fees. It also offsets any benefit you would have during the interest-free period.

Moreover, your interest rate could change with a credit card due to a variety of reasons. If you’re late with a payment, the lender might shift your card to a default rate, meaning you’ll pay significantly more in interest charges.

Factors to consider

1. Interest rates

With a 0% card offer, there’s an interest-free period upfront, but generally, rates after the introductory offer are higher than the interest rate on a personal loan, especially if you have good credit, says credit expert John Ulzheimer.

However, there’s virtually no such thing as an interest-free personal loan. With good credit, you can find a personal loan with an interest rate in the single digits, though you’ll be pressed to find close to a 0% APR loan. The average interest rate for a personal loan ranges from 4.99% to 35.99%. The average credit card rate (after the 0% introductory period is over) is a variable of 17.45%.

2. Balance transfer fee

Many balance transfer offers include a one-time fee, which can add up to about 3% to 5% of the total debt transfer, says Thomas Nitzsche, a communications lead at Money Management International.

For example, if you want to transfer $5,000 to a new card that charges 0% interest for 12 months, you might be hit with a fee of $150 to $250. That’s still cheaper than a 12-month personal loan with an 11% interest rate, which would lead you to pay $303 in interest.

3. Origination fee

These fees can be as high as 6% of the loan. In other words, if you asked for a $5,000 loan to consolidate credit card debt, you might receive $4,700, with a $300 origination fee deducted from your balance. Origination fees are typically included in the loan’s annual percentage rate.

4. Fixed rates and payment schedule

Ulzheimer says he favors personal loans in this situation because the interest rate never changes and the loan has a fixed payoff date. With predictable payments, a personal loan can help with budgeting.

Steve Repak, a North Carolina-based CFP professional and author of 6 Week Money Challenge says he favors a balance transfer because it’s more flexible than a personal loan.


5. Credit score

Opening up a new card and transferring all your credit card balances to it might push the utilization ratio on that card close to 100%, which could hurt your credit score. On the other hand, taking out a personal loan to consolidate debt could lower your utilization rate to 0%. That could help your score.

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The bottom line

Paying down debt is essential for most. These two options represent excellent ways to achieve this, but it’s important to conduct research on rates, fees and payment schedules in order to find a solution that meets your financial needs. Which route you take depends on your current circumstances and how much flexibility you’re looking for in debt consolidation.